Beverage industry stalwart Peter Brooks has three words of advice for grocery manufacturers decrying the march of retailers’ private label brands – get over it.

“It’s a fact of life and that’s where the future is heading for some categories," says Brooks, who has been bottling soft drinks, juice and water for 40 years.

“The fact is whether it’s Coles, Woolworths or Aldi, it’s their business and as long as their shareholders are happy I don’t think anyone else can do anything about it – you can fight it all you like, but that’s not going to help," he says.

Brooks’ Tru-Blu Beverages makes a range of branded drinks, such as Waterfords and Pub Squash, as well as private label beverages for most of the major retailers. He says his private label business is profitable, although not quite as profitable as his branded business. “As long as you have the right structure and the ability to manufacture products at a competitive price you should be able to be reasonably competitive in the private label business."

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For every manufacturer making money out of private label there is one struggling to make decent returns, or counting the cost when its contract is not renewed.

The rapid expansion of private label groceries at Coles and Woolworths – where house brands now account for about 20 per cent of packaged grocery sales – has had devastating consequences for some suppliers, particularly in staples such as bread and milk.

Goodman Fielder’s bread profit margins have halved over the last five years, from 18.3 per cent in 2007 to 9.5 per cent last year, due to the impact of private label bread on branded sales and low-returning private label contracts.

Goodman chief Chris Delaney said last year Goodman had “made a ­mistake" when it signed a private label contract with Coles two years before and he would not be willing to renew the contract at current prices.

Low returns for suppliers

Earlier this year Woolworths recognised the low returns George Weston was making on private label bread by agreeing to a 35¢ a loaf price rise.

In dairy, farmers claim $1 a litre private label milk is driving them out of business, but it is the processors that have borne the bigger impact.

Lion is making nil or very low returns from milk for drinking, as cheap private label milk has taken share from its branded business. Lion’s Japanese parent, Kirin, has written down the value of its dairy and drinks assets by $2 billion over the last few years.

Food industry sources say the major retailers are using private label groceries to gain market power and increase profit margins at the expense of branded suppliers, which are subsidising private label with profits from brands.

The packaged bread category is a prime example. Industry sources say the average loaf of branded bread costs $1.83 to make – $1 in cost of goods and 83¢ in indirect costs, including marketing and distribution. If a supplier sells branded bread for an average wholesale price of $2.05 it makes a gross margin of $1.05 and an EBIT margin of 22¢. Based on an average retail price of $3.05, the retailer makes a gross margin of $1 a loaf, or 33 per cent. With private label bread the cost of goods sold is marginally lower at about 85¢, but indirect costs are almost as high, about 80¢.

At an average wholesale price of $1.37 the supplier would lose 28¢ a loaf. At an average retail price of $1.97 the retailer’s gross margin would be 60¢, or 44 per cent.

Retailers say the missing part of this analysis is volume – lower private label prices can drive strong volume growth for suppliers, which can more than offset lower profitability per unit.

They also point to the success of small bread makers such as Bread Solutions, which has been supplying Coles with home-brand par-baked and artisan bread since 2007.

Misuse of market power

According to a landmark study, ­Private Label Strategy, published by Harvard Business School Press in 2007, there is an “inherent conflict for manufacturers between retailers as customers and retailers as competitors".

Retailers are inclined to devote their best shelf space to their own brands, and often want to copy supplier innovations as fast as possible for their own brands. “The mere introduction of private label in a category can significantly affect the supply terms negotiated between the retailer and branded goods manufacturers," the study says.

These scenarios will be all too familiar to the 50-odd suppliers that have complained to the Australian Competition and Consumer Commission that the big retailers are misusing their market power.

Coles and Woolworths have consistently dismissed allegations of systemic abuse of market power and deny they favour own-brands over branded products. “If we owned the shelf space, the shelf would look very different," Woolworths managing director of Australian supermarkets, Tjeerd Jegen, says. “The customer owns the shelf space and the customer decides," he says.

“If brands do well they end up with 90 per cent of the category, and good on them.

“Where customers can’t see the same value proposition we’d probably do better with own brands."

As part of Woolworths chief executive Grant O’Brien’s strategy to defend and extend its share of the $86 billion grocery market, the retailer plans to double the sales penetration of private label brands over five years.

Less choice for customers

Private label products comprise 6 per cent of stock-keeping units on Woolworths shelves and 11 per cent of total sales. When it comes to packaged groceries, private label brands account for 18.3 per cent of sales at Woolworths, up from 16.8 per cent two years ago, according to Nielsen scan data.

Jegen denies that more private label means less choice for consumers.

“It’s complementing, not replacing brands – we are still very focused on making sure we are a house of brands," Jegen says.

Jegen rejects suggestions that only the large branded manufacturers can afford to subsidise house brands. Most of Woolworths's Macro and Gold brand suppliers are cottage-industry manufacturers or independent businesses, he says.

“I think private label provides a great opportunity for small manufacturers to grow their business with us and grow their volumes in a way they could not do themselves because they don’t have budgets for marketing and merchandising," he says.

“For bigger manufacturers, private label provides a great way to fractionalise their costs, and if the brands keep on innovating and are relevant to customers, they have nothing to fear from house brands."